The dictionary definition of income is “how someone manages to earn or make it (money).” But you’re here because you know there are two different types of making money. Today we are focusing on the difference between active and passive income.
There are two different types of income:
- Active Income: Money you must physically work for (i.e. your day job). No work=No Pay
- Passive Income: Money you earn without working for. (i.e. Dividends from investments, interest from savings accounts, royalties, etc).
- Passive income is money keeps growing–even when you sleep, take a vacation, or are sick.
A Couple Ways to Earn Active Income
There are a couple ways you can earn active income–that is getting paid after you exert effort. Maybe it’s physical effort like construction or mental effort like painting a picture or writing a book.
Either way, you don’t get paid unless you do something for your customer or employer.
Here are a few quick examples of earning active income:
- Holding an office job
- Working at a fast food restaurant
- Mowing lawns after work to make more money
For these three examples, you don’t show up to the job, you don’t get paid.
A Couple Ways to Earn Passive Income
If you’re like me, the active income ideas are good but they aren’t your only way of making money. These are a few other ways to make money without exerting effort:
- Investing in stocks and earning dividends
- Earning interest from your savings account deposits
- Start a blog or YouTube channel and earn income from “refer-a-friend links” and brand partnerships
While initial effort is required to earn passive income. You do virtually nothing else after you create the initial product. For example, I invest in index funds and earn have earned a dividend every December since I started investing 20 years ago.
How I “Discovered” Passive Income
In high school, I was first introduced to these two terms in the book Rich Dad Poor Dad by Robert Kiyosaki. He didn’t invent these terms, but this was one of the first financial books I had ever read.
This concept was reinforced with his board game, Cashflow, where the winner of the game wins by having the most passive income & being able to “afford” your dream goal (like having a fishing cabin on a mountain lake).
The goal of the game is to earn more passive income than your monthly expenses. The sooner you do it, the sooner you can retire. In real life, we afford retirement because of years of putting money in the bank or investment accounts and earning interest on these deposits.
Why is Passive Income Important?
Here’s my main reason for earning passive income: “Work Smarter, Not Harder For Your Money.”
For most of your working career, you can do just fine only earning active income from your 9-5 job and a few side hustles. But, there comes a time when you (a) no longer want to work to survive or (b) you’re physically unable to work due to illness or injury.
If you manage your money well, you will have passive income that can allow you to gradually scale back your active income efforts such as taking a job that works fewer hours or being able to retire early. Passive income can be the difference between living comfortably and living well (Hint: A happy life isn’t solely about makings lots of money & sound investments).
As will be discussed further in my next post, the difference between active and passive income is more than a definition and if you physically work to earn the dollar. But we need to understand the basics of Financial Literacy 101 to establish the groundwork for financial freedom.
If you’re not earning passive income, you need to start pursuing ways to earn it. Active income is probably the easiest to earn because you work and earn instant payment.
With passive income, it can take months or years to earn consistent income streams. And, it can be decades before your monhthly passive income earnings can replace your monthly salary.